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I’m generally a huge proponent of 401(k) plans, urging people to fund them as much as possible to avoid a financially shaky retirement. (My Next Avenue colleague, Larry Carlat, calls me the scariest man he knows because my blog posts are often filled with warnings. Larry: Did you see the new AARP study that found middle-class workers age 45 to 64 saw their overall financial security plummet 32 percent between 2004 and 2010?)

But I’m now starting to think too many of the 51 million Americans who are investing in 401(k) plans shouldn’t be. Maybe you’re one of them.

How Employees Drain Their 401(k)s

The problem is that, according to just-released research from HelloWallet, a financial advisory firm based in Washington, D.C., a large and growing number of employees — one in four 401(k) participants — are breaking into their retirement accounts to use the money for financial emergencies and other purposes.

They’re making hardship withdrawals, cashing out of their plans entirely when leaving their jobs and taking out 401(k) loans. Employees are tapping these funds typically to douse the flames when an unexpected emergency has set their finances on fire. As a result, they could be putting their financial future at risk.

In retirement parlance, each of these moves is known as a 401(k) breach.

More than 25 percent of employees using 401(k) plans have taken money out of them for “non-retirement spending needs” — amounting to more than $70 billion in annual withdrawals, the study says. (I’m a little suspect of that $70 billion figure, but the trend is undeniable.)

The Employee Benefit Research Institute says 21 percent of all 401(k) participants eligible for loans took one in 2011, up from 18 percent in 2008. (The average unpaid balance: $7,027.) And an Aon Hewitt study found that roughly one-third of employees in their 50s and 60s with 401(k)s cash out of the plans when they change jobs.

Midlife Employees Tap Plans the Most

Workers between age 40 and 59 are the ones most likely to tap their 401(k)s through withdrawals, cash outs and loans, according to HelloWallet.

“They have the most intense financial pressures, with mortgages, credit card debt and maybe kids in college,” says Matt Fellowes, founder and chief executive of HelloWallet. “When they run into unexpected expenses, it’s a big shock to their financial system. You can roll with the punches when you’re in your 20s or 30s. But by the time you’re in your 40s or 50s, there’s not a lot of room for error.”

It isn’t that 401(k) breachers are looking at their retirement plans as piñatas they can empty at will.

The Root Cause of Breaking Into 401(k)s

The problem, Fellowes says, is that many have failed to create emergency savings funds outside of work, so they resort to their retirement plans to handle life’s unforeseen blows.

“If a household lacks emergency savings, they have twice the probability of breaching their balances, compared to households that have sufficient emergency savings,” the HelloWallet study says.

Workers are up to six times more likely to take out a loan against their plan balance if they lack emergency savings. “But if people build up emergency savings effectively and budget their money, the need to take out 401(k) loans will be substantially reduced,” Fellowes says.

Not surprisingly, lower-income employees are the most likely to pull money out of their 401(k)s, since they’re the ones in greatest danger of needing cash for an emergency.

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“The fault, dear Mr Eisenberg, is not in our 401(k)s, But in ourselves, that we are foolish.”

My high school English teacher would be proud I recalled this line to paraphrase. I agree with your warning, for those unable to resist the urge to raid their accounts, they might rethink how they are depositing. The penalty and tax on the lump sum withdrawals can make them worse off than not participating at all.

I think young workers who have no emergency savings should probably fund a Roth IRA first, since in a pinch, they can take their contributions out without penalty. (But if it’s an emergency fund, then it shouldn’t be in stocks.) If they can fund both a Roth IRA and the minimum 401(k) contribution needed to capture the full employer match, that’s ideal. But I’m not as down on 401(k) loans as I used to be. True, they can become a problem if a worker is fired or switches jobs. (The ex-employer may demand immediate repayment.) But if someone in a relatively stable job is deciding between, say, borrowing from his own 401(k) and paying interest to himself and taking a PLUS loan (to pay for their kids’ college) at 7.9%, I’d opt for the 401(k) loan. I’ve seen people take these loans–even as they continue to make new 401(k) contributions–to get over a college cost hump. They pay back the loans and ultimately end up with more in retirement savings (and more in tax savings) than if, say, they’d stop contributing to a 401(k) while paying college bills of taken the PLUS loan.

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